How Venture Leasing Adds Millions To A Startup’s Equity Value

What is venture leasing and why has it ended up being so attractive to venture capital-backed startups?

Venture Leasing

Venture leasing is just like regular leasing in the sense that it is a service under which one party provides an asset to another party for a short period of time. In return, the second party provides a payment to the first party.

TL;DR – Where does venture leasing fit into the overall startup funding mix? The reasonably high expense of equity capital compared to venture leasing means it has its place. Startups, especially those that build a technological hardware product, have actually turned to venture leasing. They have used it as a significant source of funding to support their development and to increase enterprise value (CAP value) much faster.

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A Case Study

The CEO of a startup that develops nanotechnology applications for the defense market (NANO Co), had recently closed a US$ 20 million equity round. Now it seemed that they had underestimated that capital needs. With just four months of runway (cash) from a previous equity round left, they had started contacting the market again to secure a bridge round. Any delay in securing extra capital would cause NANO Co to reduce its cash burn rate which in turn would cause them to fall short of an important delivery deadline.

The limited possibility of raising additional equity earlier than anticipated and at a much lower enterprise (CAP) value than expected was a sobering thought for the CEO and his board. As the situation appeared to be headed downhill, the company’s CFO broached the idea of getting $ 1.5 million in venture leasing. Approximately $ 600,000 of this funding would be utilized to fund existing devices. The balance could be used for upcoming acquisitions of computer workstations, servers, software, and test equipment.

The CFO met with the CEO of a Connecticut-based, Technology Leasing company (LEASE Co). It specialized in equipment financing for venture capital-backed start-ups and emerging development companies. Cash from selling and leasing back existing devices along with a leasing line to include brand-new equipment enabled NANO Co to operate for three extra months without additional equity. Venture leasing had actually created millions of dollars in additional enterprise value for NANO Co’s shareholders.

Like NANO Co, a growing number of venture capital-backed startups are taking advantage of venture leasing to increase enterprise value much faster between funding rounds, and be able to continue or expand CAPEX programs.

Which Companies Are Suited

The term venture leasing describes equipment financing provided by equipment and technology leasing companies to pre-profit, early-stage startups that have received investment from venture capital investors. Like NANO Co from the Case Study above, these start-ups need basic infrastructure like computers, networking devices, software applications, and devices for production and R&D.

Advantages Of Venture Leasing

The advantages of venture leasing have been mentioned below:

1. Specific and Lean: The best part about venture leasing is that it provides the leasing companies with a lean against a very specific asset. Investors offering venture debt may want to create a lien on the company as a whole and even the intellectual properties of the company are at risk at this stage. However, when it comes to venture leasing, even in the event of a default, only the specific asset is at risk.Also, venture leasing is often referred to as “just-in-time financing”. This is because start-up companies can decide to take the equipment on lease exactly when they require it. This allows them to be more efficient from an operational point of view and save costs.
2. Lowers Dilution: Another main benefit of venture leasing is that allows founders to obtain funds from financiers at a lower cost as compared to both venture debt as well as venture capital. Venture capital can be considered to be the most expensive method since it leads to a permanent loss of equity. Venture debt is also more expensive as compared to venture leasing. This is because venture debt is about providing unsecured loans whereas venture leasing is about providing loans that are secured by tangible assets.Founders can use venture leasing to ensure that their precious equity capital is not locked up in assets. Instead, they utilize the capital of a venture leasing company to finance equipment while conserving their own capital to increase the growth rate of the firm.
3. Suitable for Asset-Heavy Companies: Even though most startups are leaning towards asset-light companies, there are still some businesses that require significant investments in physical assets. This is where venture leasing comes to the rescue. Even high-tech information companies can use venture leasing to lease out their computer equipment instead of buying it.

Disadvantages Of Venture Leasing

There are several disadvantages of venture leasing as well. Some of these disadvantages have been written below:

1. Cannot Customize Equipment: One major problem with venture leasing is that it is impossible to customize the equipment for the company’s use. Venture leasing companies want to ensure that they have standard equipment available which can be used by several clients. If one customer is unable to pay the lease amount, these companies lease the same equipment to another customer. Hence, start-up firms can use this arrangement only if they need standardized equipment.
2. Not suitable for the Long Term: Most start-up companies use venture leasing as a stop-gap arrangement. This is done to ensure that their capital is deployed to generate maximum returns in the short run. However, most companies want to own their own assets in the long run. Hence, it is important to ensure that venture lease contracts provide companies with the option to buy the equipment. If this option is not present, the company may have to give up its asset base and then create a new one again with its own money.
3. More Expensive than Buying Outright: In the short run, leasing can be cheaper since it allows the start-up company to conserve its capital. However, it is important to note that the leasing company is also making a return on its investment and is also charging a management fee. All these amounts end up over the long term. Hence, venture leasing can turn out to be significantly more expensive if used over the long term.

How Do Venture Leasing Companies Qualify Potential New Clients?

Venture leasing companies look closely at a number of aspects. Two of the primary ingredients of a successful new venture are the quality of its management group and its venture capital sponsors.

After determining that the caliber of the management team and venture capitalists are high, a venture lessor looks at the startup’s company model and market potential. How much money is on hand and how long will it last the startup according to the forecasts? When will the startup require the next equity round?

To mitigate this threat, many skilled venture lessors require that the startup have at least nine months of cash on hand prior to continuing. Normally, startups approved by venture lessors have raised at least $ 5 million in venture capital and have actually not yet exhausted a healthy portion of this amount.

Where Can Startups Access Venture Leasing?

Part of the infrastructure supporting USA-based startups is a handful of national leasing companies that specialize in venture leasing.

In 2023, partly as a result of the valuation correction that occurred in 2021/2022, many Hedge Funds, PE Funds, and Financial Services Groups are entering into the equipment leasing space.

And unlike previous years, these newer entrants are able to work with early-stage startups whose total equipment lease needs are modest, i.e. in the hundreds of thousands of dollars, as opposed to millions.

Here is an article that lists five such companies.

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About The Author:

James Spurway is an Angel Investor, Advisor, Mentor, Speaker, former Commercial Pilot, and Author specializing in raising debt and equity funds for pre-seed or early-stage seed rounds for Startups in the Fintech, DeepTech, AgTech, ClimateTech, and AgeTech verticles. He lives in Singapore and has spent the past 30 years living and building businesses in Hong Kong, Vietnam, Germany, Switzerland, Monaco, the USA, Thailand, the Philippines, and Australia, where he was born.